The Fed Is Bullish On America

Emerging markets are in a panic and job growth in the U.S. hit a significant snag last month. Nevertheless, the Federal Reserve is bullish on America.

So much so that the policy setting Federal Open Market Committee shrugged off those two economic elephants in the room and voted unanimously to press forward with its plan to gradually wean the economy from easy-money stimulus policies.

But if emerging economies, once magnets for investors before the Fed began scaling back easy money, are now struggling, and U.S. labor markets a paradox as the unemployment rate falls for all the wrong reasons, where is the Fed finding cause for its optimism?

Thursday’s GDP report, which showed the U.S. economy expanded at a 3.2% rate in the fourth quarter, is a good place to start.

Root Causes for Fed Optimism

“This GDP release cements the conclusion that U.S. economic growth has finally accelerated from fair to good, and provides evidence that this acceleration will continue into 2014,” said Doug Handler, chief North American economist at IHS Global Insight.

The Fed has forecast that the economy will continue to expand at around that 3% rate throughout 2014 and at an even stronger rate in 2015 without stoking inflation.

Throughout the five-year, stop-and-start recovery following the 2008 financial crisis, the headline unemployment rate was often used as a key barometer of the health of the U.S. economy. But as that number has proven increasingly ambiguous, the Fed has turned to other guideposts for setting policy and issuing forecasts such as GDP and inflation.

It’s worth digging deep into Thursday’s GDP report in order to find some of the root causes of the Fed’s optimism.

Cliff Waldman, senior economist for the Manufacturers Alliance for Productivity and Innovation (MAPI), a public policy and economics research organization in Arlington, Va., pointed to two aspects: an increase in business equipment investment and a boost in exports.

Corporate spending on equipment jumped by 6.9% in the fourth quarter from the prior quarter, sharply higher than the 0.2% increase between the third and second quarters.

“Companies have lots of cash on hand but they’ve been sitting on it. This shows that they’re starting to spend it a little bit and that’s a good thing to see. We needed that,” said Waldman.

Petroleum Exports “Big Driver” of Growth

Just as important as the spending itself is the reason companies are spending: confidence.

If companies are willing to invest in equipment that means they’re likely looking to expand, which will lead to more jobs and hiring.

“When you see a number like this it’s a good sign. It could lead to job strengthening down the line,” said Waldman.

Real exports of goods and services increased 11.4% in the fourth quarter, compared with an increase of 3.9% in the third, a sign that despite the current turbulence in emerging markets demand for U.S. goods remains healthy.

John Sylvia, chief economist at Wells Fargo Securities, said in a note to clients that the “big driver” of growth in exports in recent months has been petroleum exports, which increased by $698 million in November, boosting total petroleum exports to another record high.

“Not only is the American energy boom underpinning export growth, it is reducing demand for foreign oil,” said Sylvia.

Meanwhile, Waldman cautioned that the turbulence in emerging markets is a story that might not be going away. The Fed may not have mentioned it in their FOMC statement yesterday, “but there’s no question they’re studying it,” he said.

The end of Fed-printed easy money has been cited as a factor in the emerging markets meltdown as investors who once sought higher returns in EMs are now abandoning those markets.

But Waldman said China’s economic slowdown, which he described as “deeper and wider” than many had anticipated, could have broader and more long-term implications on those struggling economies.